District Court Holds Damages for Negligence and Breach of Contract Are “Indivisible”

The United States District Court for the District of Rhode Island, applying Rhode Island law, has held that a jury’s finding of negligence and breach of duty against an insured constituted a “Wrongful Act” under a D&O policy’s entity E&O endorsement.  Bank of Rhode Island v. Progressive Cas. Ins. Co., 2014 WL 1931906 (D.R.I. May 15, 2014).  The court also held that, where damages awarded against the insured for negligence and breach of contract were “indivisible,” the insurer has a duty to indemnify the damages at issue to the extent the amounts would not otherwise be barred by an exclusion.  Finally, the court held that an allocation must take place between covered Loss and uncovered amounts in connection with the applicability of the policy’s “Internet Services Exclusion.”

The insured bank was sued for alleged mismanagement of a client’s commercial bank accounts and line of credit in connection with a scheme of one of the client’s employees to embezzle funds from the client’s bank account.  The employee allegedly improperly reconciled sales reports and bank deposits and electronically transferred funds from the client’s line of credit to cover the operating accounts.  After a jury trial, the jury returned a mixed verdict that found, among other things, that the bank breached its “business loan agreement” with the client by providing online access to the line of credit to the employee and was negligent in breaching its duty of ordinary care to the client.  The jury awarded the client $2.1 million in damages and interest.  The insured sought coverage under its D&O policy’s entity E&O endorsement, and a coverage dispute ensued concerning whether the insurer had a duty to defend and indemnify the insured, and if so, the extent to which an allocation of covered Loss was appropriate.

In ruling on the parties’ cross motions for summary judgment, the court first addressed whether the underlying action alleged a “Wrongful Act,” defined as “any actual or alleged act, error, omission, misstatement, misleading statement, neglect or breach of duty by the Company or by any person or entity for whom the Company is legally responsible.”  In this regard, the court held that “the jury’s findings of negligence and breach of duty clearly establish that a Wrongful Act occurred.  The verdict demonstrates a finding that [the insured bank] engaged in an act, error, omission, neglect, or breach of duty resulting in a loss.”

The court rejected the insurer’s contention that the jury’s award was attributable to the breach of contract claim and that the insured was not “legally obligated to pay” such amounts.  The court noted that “despite separate and distinct causes of action and conduct that gave rise to liability . . . [the client’s] suffered damages were indivisible.”  The court further held that “[s]imply because the damages could not be parsed between various causes of action does not change the fact that [the insured bank] suffered a Loss because of the jury’s negligence verdict and nor does it relieve [the insurer] of its obligation to pay the Loss incurred.”

The court next addressed the applicability of the policy’s “Internet Services Exclusion,” which provided, in relevant part, that coverage was precluded for “any Claim arising out of or in any way involving the Company's providing . . . services through the transmission of data to or from an Internet website.”  The court recognized that “at least some of the negligence claims against [the insured bank] in some way involved providing services through the transmission of data over the internet” but that “many of the facts supporting the negligence claims against [the insured] do not fall within the exclusion,” such as the failure to notify the client of the transactions.  The court therefore concluded that the “Internet Services Exclusion excludes some portion of the negligence award and it does not exclude other significant portions.”  For this reason, the court held that, pursuant to the policy’s allocation provision calling for the parties to use their “best efforts” to reach a proper allocation, an “allocation must take place” between covered Loss and uncovered amounts from the jury’s verdict.